Rising Mortgage Rates Hit These ETFs

Mortgage rates hit seven-year highs this month, making troubling headlines for would-be home buyers shopping for that 30-year mortgage, but also signaling tough times for fixed-income ETF investors in general.

Directly in the spotlight is the iShares MBS ETF (MBB), which consists of a portfolio that’s currently allocated roughly 75% to mortgage-backed securities (MBS) and 25% to cash. The $11.75 billion fund has seen net asset inflows totaling about $266 million so far in 2018, but earlier this month faced net redemptions of $321 million.

Share prices of MBB are currently trading at lows not seen since March 2017.

Unfortunately for fixed-income ETF investors, the rise of mortgage rates is only part of the troubling picture. The multiyear milestone for mortgages comes as Treasury yields are also inching higher—the 10-year is up more than 0.60% year-to-date, now above 3%. MBS and Treasurys tend to be highly correlated, and as yields rise, prices typically fall.

Aggregate bond ETFs tracking or orbiting the popular Bloomberg Barclays US Aggregate Bond Index help show that the pinch this year is stemming from more fronts than mortgages alone.

Aggregate Bond ETFs

These funds own various segments of the bond market, and in 2018, every segment from municipals to MBS to investment-grade corporates to Treasurys is in the red.

The $36 billion Vanguard Total Bond Market ETF (BND), which tracks the Bloomberg Barclays U.S. Aggregate Float Adjusted Index, has about 21% of the portfolio in MBS, according to FactSet data. These ETFs, too, are trading at lows not seen since spring 2017, extending losses year-to-date:

But MBS could be one of the most resilient parts of these portfolios this year despite the rise in rates. A look at actively managed bond ETFs seeking to outperform the Agg show that these funds are achieving that outperformance in part by allocating more heavily to MBS, which, while down for the year, isn’t pressured as much as other segments of the bond market.

TOTL, managed by Jeffrey Gundlach’s DoubleLine Capital, has a broad mandate allowing it to invest in various fixed-income sectors globally. The ETF is outperforming the Agg as well as its main actively managed competitor, the PIMCO Active Bond ETF (BOND), which has about 34% of its portfolio tied to mortgage. (Both are outperforming the Agg this year).